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Finance > Corporate Governance > Flashcards

Corporate Governance Flashcards

1
Q

Tirole’s Definition

A

“The ways in which the suppliers of finance to companies asssure themselves of getting a return on their investments” (2006)

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2
Q

General

A

System of checks and balances to mitigate agency costs.

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3
Q

Agency cost examples

A
  1. Insufficient effort
  2. Extravagent Investments
  3. Entrenchment Strategies
  4. Excess Risk Averseness
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4
Q

Insufficient Effort

A

Allocation of work time to preferred tasks or avoiding inconvenient but valuable activities => avoiding renogotiation of supplier contracts, thorough appraisals, admin stuff, etc

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5
Q

Extravegent Investments

A

Pursuit of pet projects and empire building at expense of less glamourous high NPV projects=> misaligned priorities

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6
Q

Entrenchment Strategies

A

Actions that hurt shareholders to secure own position
=> investing in specific technologies/assets that align w/ their expertise
=> enganging in M&A to increase complexity of firm to increase administrative burden=> more need for managers
=> Use of earnings management to manipulate firm perfomance, e.g. aggressive revenue recognition (e.g. Groupon/Tesco)

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7
Q

Self Dealing

A

Seeking personal benefit from business deals
=> Nepotism
=> making business decisions to maximise personal social capital instead of shareholder value

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8
Q

Excess Risk Averseness

A

Managers cannot diversify away specific risk like shareholders can=> all of their human capital tied to one firm

=> Shareholders only care about market risk but managers care about both specific and market risk so higher required rate of return for positive NPV projects

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9
Q

Enron

A

Became darling of wall street for integrating technology solutions and complex finance into the energy business

Unravelled after found using SPVs o conceal huge debts off balance sheet and understate leverage to Shareholders

Shares crashed=> shareholders paid price

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10
Q

Moral Hazard in Practice

A

Effective incentives for high performance:
1. Implicit Incentives
=> passive incentives not directly tied to compensation
- risk of firing
- threat of proxy fight/takeover as result of poor performance
- threat of bankruptcy
- product market competition

  1. Explicit Incentives
    - bonuses=> tie compensation to performance=> encourages myopia
    - compensation base=> provides salary insurance
    - share options=> alternative to bonuses, aligns interests
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11
Q

What is Executive Compensation?

A

Describes salary packages of a companies exec managers

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12
Q

Bell and van Reemem (2013)

A

Wage inequality in developed economies may be driven by executive bonuses

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13
Q

Murphy (1999)

A

Cross-country, firm , industry and time heterogeneities

=> Exec compensation varies across countries/industries

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14
Q

Why is CEO Pay so high?

A
  1. Promotion tournaments
    => High pay for senior roles incentivise those in lower roles
    => Pyramid structures (e.g. Banks, Law firms…)
  2. Signalling
    => High pay packages act as a signal of firm/employee quality
    => market assumes higher paid workforce = more productive workforce
    => also communicate healthy financial position and confidence in future cashflows, assume higher pay= higer capacity to pay
  3. Not always true firms may leverage brand to pay less, lower pay may be signal of higher firm quality, wider benefits
  4. CEOs are highly skilled and uniquely fitted for their position low supply/high demand
  5. CEOs exposed to both market and industry risk
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15
Q

Bandiera et al (2017)

A

17% of CEOs misplaced for the job

=>CEOs affect firm performance but they are not irreplaceable

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16
Q

Jenter and Kanaan (2015)

A

Data from over 3000 CEO changes between 1993 and 2009=> strong evidence for high turnover
=>CEOs are punished for industry/market performance

17
Q

Hirschman (1970)

A

Exit and Voice: 2 broad approaches to corporate gov

  1. Exit - Anglo American=> shareholders sell if unhappy
    - well developed stock market
    - substantial disclosure requirements, transparency requirements
    - shareholder activism
    - Proxy fights, group of shareholders consolidate votes to drive agenda
    - takeovers
  2. Voice German/Japanese=> work with management
    - Trust between managament and Shareholders
    - Cross shareholding among firms/between firms and banks
18
Q

Exit - Drawbacks

A
  1. encourages myopia
    => managers focus on short run profitability to avoid share sellout
    => no cohesive vision between mangement and shareholders
  2. Limits amount of trust between management and shareholders
19
Q

Voice - Drawbacks

A

Limited Productivity=> reduced firing risk, less incentive for high effort (not compelling, more enlightenment and potentially more freedom to lead)

Stock market liquidity falls, investors have long time horizons

Shareholder have less leverage, may exacerbate agency issues driven by CEO hubris (Like empire building, etc)

20
Q

Does M&A add value?

A

Grossman and Hart (1980): Takeover bids only successful only if they offer at least full value for the target

=> atomistic shareholders have no impact on final bid price=> still recieve any post takeover value gain if they don’t tender offer but others do

=> no incentive for them to accept any offer below FV

21
Q

Does M&A add value? Toehold Purchases

A

Toehold purchases = purchase of small % of target company for announcement 5% in US, 3% in UK
=>allows acquirer to get a stake of firm before disclosing intent to make formal bid

=>after disclosure price rise in response so only small gain (unless firm possesses some private info)

22
Q

Synergies

A

When Value to acquirer is larger than book value of target
1. Economies of scale => why firms tend to consolidate during downturn, efficiency gains allow for cost savings

  1. coplimentary assets may create value greater than sum of parts (Teece 1986)
  2. More capacity to leverage tax shield=> for tax capital intensive industries (construction, energy, utilities)
  3. Human Capital Benefits - access to more effective management
23
Q

Takeover Defences

A

Protection measures to prevent predation of “cheap” undervalued firms.
=> generally pushed by incumbent management and local politicians

can be viewed in 2 ways:
1. create value for existing shareholders by forcing bid price up

  1. provide excess security for inefficient/incompetent managers and board members
24
Q

Takeover Defences - Poison Pill

A

Specially designed shareholder rights plan
=> Gives shareholders of target option to buy stocks of target/acquirer at a discount in case of successful takeover
=> can be set up quickly and without shareholder approval

2 types:
Flip in: Target issues new shares to shareholders at a deep discount=>instant profit for shareholder’s
=>dilutes shares held by acquiring, raises cost of TO

Flip over: Target shareholder’s have option to buy bidders stov at discount post-acquisition
=>drives down share price of bidder

25
Q

Poison Pill - Varaiya (1987)

A

Poison pills raise cost to the winning acquirer in the form of higher premia

26
Q

Poison Pill - Malarest and Walkling (1988)

A

Announcement of Poison Pills generate significant negative stock returns their abandonement leads to significant positve E[profits]

27
Q

Poison Pill - Heron and Lie (2006)

A

Poision Pills strengthens bargaining power of incumbernt shareholders, raising bids and increases.
BUT takeovers no less likely

28
Q

Takeover Defence - Golden Paraschute

A

Target management get large severence package if a bid is successful=> dont need shareholder permission in US, do in UK

Examples:
Meg Whitman, CEO HP has $91m severence package
Staples and Office Depot proposed merger => Office Depot CEO entitled to $39m in accelerated vesting of stock options

29
Q

Takeover Defences - White Knights

A

Management lines up friendly bidder to tend of hostile approaches
=> P. Soo-Shiong’s $70m investment in Tribune Publishing as they fend off takeover from Gannett Co.

30
Q

Takeover Defences - Staggered Board

A

Only allows a proportion (usually 1/3) of board to reappointed each year.

Data suggests negative correlation between staggered boards and firm value (Gomper et al, 2003)
=> may discourage acquisitions that would increase shareholder value (Grossman and Hart, 1980)

Job security for Managers/Directors encourages LR decision making (Stein, 1988)

31
Q

Takeover Defences - Supermajority

A

Requiring more than 50% of shareholders to approve a merger

=> depends on company charter but usually 67-90%

32
Q

Takeover Defences - Leveraged Recapitalisation

A

Target takes on additional devt w/ intention of paying a cash dividend or repurchasing stocks to increase D/E
=>increase leverage ration makes target less attractive

33
Q

M&A The Bidder - Rational

A

Rationale:

  1. Synergies
  2. Undervalued Target
  3. Poor Management
  4. Tax Benefits - D/E increase buids up tax shield

C

34
Q

M&A The Bidder - Concerns

A

Moral Hazard

  • FCF agency cost (Jensen, 1984)
  • Empire building: vanity project, signalling, salary leverage

Overpayment
=> CEO Hubris (Hayward & Hambrick)
=> Bidding wars “winner’s curse” (Varaiya, 1988)

Diversification
=>Shareholders can diversify away specific risk themselves so do not value firm diversification (Porter 1987)
=> Shareholders may face borrowing constraints
=> Also high growth, larger firms may have access to better growth opportunities than individual shareholders

35
Q

Voice: Blockholders

A

Shareholders with large % of shares
Vote to improve management instead of just selling shares
=> indirect, influence management through board
- less disruptive
- no loss in share value do to market inefficiency
=> unlikely to be pursued by atomisitic investors, not worth the cost

36
Q

Anglo/American Voice

A

Blocks tend to hold shares for less than 12 months
=essentially exit investors

US Banks prohibited from active investment in non-financial firms, and cannot influence management
=>risk equitable subordination

Increased appointment of independent directors
=>Potential reverse causality, can’t observe counter factual

37
Q

Voice downsides

A

Active investors act in self interest=> expropriate other shareholders in pursuit of private agenda

Insider Blockholders (management) have interest in seeing stocks rise
=>BUT may opt to max private benefits instead
=> only bear a proportion of costs associated with managerial decisions but gain all benefits

Bank Blockholders unlikely to interfere unless risk of financial distress

38
Q

Bertrand and Mullainathan (2000)

A

Skimming Theory
CEO set own pay => leverage postion to manipulate compensation committee

Correlation between size of Shareholders and average CEO pay. 7.5% w/o large shareholders, 2.5 w/ large shareholders

Firms w/ blockholders had salaries more sensitive accounting performance=> less sensitive to “luck dollar”

Skimming more likely to occur when there is less scrutiny
=> stock options not realised on FS till exercised=> can go unnoticed
=> more scrutiny during periods of high exogenous performance

Finance (6 decks)

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